Byrne's Eye View

Michael Lewis has discovered Meredith Whitney, so it's time to address the phenomenon: she is not a great analyst. She is not an especially good analyst. She has made good calls with bad reasoning, so I suspect that her status is mostly due to luck. She's not a leader -- she's a mascot.

Highlights from the article:

It all started back on Oct. 31, 2007, when she published her now-legendary report on Citigroup Inc. In it, she pointed out that the company's dividend now exceeded its profits -- the bank was handing money back to its investors faster than it was taking it in from its customers.

The U.S.'s biggest bank was being managed to ensure only its bankruptcy. Citigroup would need either to raise capital, sell assets or slash its dividend -- possibly all three.

Brilliant! Their earnings, which dropped due to writeoffs, were lower than their dividend! Ensuring bankruptcy! Oddly, I've seen several companies that pay more in dividends than what they earn, and which don't seem to be collapsing -- they seem to be winding down, or maintaining a dividend that reflects their long-term earning power rather than their short-term results. People used to admire AT&T because they had the same dividend throughout the Depression ($9/share, even though their earnings collapsed from $15/share to $6/share).

Even more strangely, Lewis suggests that they would have to sell assets to deal with this problem. For someone who worked at a large investment bank, he doesn't seem to understand how banks work. Citi earns a high return because they have lots of assets -- they borrow at one rate, lend at another, and return a fraction of the difference to shareholders in order to compensate them for not being a priority in the event of a liquidation. If the company wants higher earnings, they need to go for more assets.

Whitney now says ``that call was absolutely straightforward, the easiest call I've ever made.'' But at the time, none of her fellow analysts was saying anything like it.

It's easy, and nobody else is doing it. Vote of confidence, or a good reason to consider whether it's really so smart in the first place?

Parsing possible explanations for her success, Lewis offers this:

Working for a smaller firm, and largely unnoticed, she had nothing to lose from making wild, negative predictions. If she was wrong, no one would pay her any attention; if she was right, she'd be famous.

...

The trouble with this explanation is that Whitney has had a bit too much good luck to be merely lucky. Thrust into the limelight by Citigroup's collapse, she's moved on to helping other banks collapse, too.

Lewis is also ignorant of how other bubbles form. In 1999, he could have written that the success of Internet stocks had to be real -- after all, Yahoo! and AOL could have been a fluke, but Pets.com and Webvan also had huge valuations, so there must have been something besides luck.

Of course she wasn't just lucky. Once she had a reputation, her predictions became self-fulfilling prophecies. Even a 5% chance of ending a quarter with investors asking "How could you have held X when the most admired analyst on the street said it was going under?" is too much.

Lewis also revises history:

On Oct. 31, 2007, everyone else was still more or less thinking of these firms as they had since at least the early 1980s, when they became masters of the universe. Since then the markets haven't seriously questioned whether the firms at the heart of capitalism actually knew what they were doing with capital.

This graph seems to show that people were talking about such issues months earlier, and that Whitney didn't make much of difference.

And that turns out to be his argument. That Meredith Whitney was the first person to understand that tangible book value doesn't mean the same thing as book value, and that in a crisis, a large bank can't be liquidated for their last reported shareholder's equity. I thought that was understood since the beginning of financial markets; I thought people had long been aware that banks get lax -- in their lending and their accounting -- during booms, and that crises are necessary to keep this from getting out of hand; I thought the possibility of a recession was factored into every bank's price. I also thought Lewis was an informed observer who could tell the difference between talent and hype -- but I guess that went too far.